With Defaults Down, Banks and Bond Markets Find Nothing to Fear

By FLOYD NORRIS

Published: November 19, 2004

CALL it the ''What, me worry?'' market. The dollar may be quivering and economic recoveries in Europe and Japan may look shaky. But this is a time of confidence for those who lend money to corporations.

That confidence is shown by an increasing willingness to lend money at low rates to even those with dubious credit. The fear of default seems to have almost vanished.

The bond market has been exuding confidence for much of 2004, evidently assured that world growth would keep profits pouring in. But the trend has accelerated this month, as oil prices slipped and investors expect that business conditions will improve with President Bush and the Republicans in firm control in Washington.

This week, the Federal Reserve released its quarterly survey of bank lending officers and found that banks said they were easing credit terms and getting less for their loans to corporate customers. And when they were asked if they were concerned that conditions might worsen over the next year, few saw this as likely while a larger number thought that things would continue getting better.

The confidence is also reflected in the stock market. There, the underlying strength is obscured by the fact that some large stocks have not done as well as the overall market. This month's rally has left the Standard & Poor's 500-stock index up 6 percent for 2004, but more than 20 percent below the 2000 peak.

Still, most stocks in the index are well above where they were when the market peaked. The S.&P. reflects that by measuring the index in an alternative way -- one that assumes that an investor put an equal amount of money into each stock, rather than buying more shares in larger companies. On that equal-weighted basis, the index is up 11 percent this year -- and is more than 20 percent above the 2000 peak.

Why the confidence? Economies are generally performing well, and companies are making enough money that they do not need to borrow much. Default rates are down in the United States, and in Europe there have been no defaults on high-yield bonds in 2004. Investors, surprised that long-term interest rates have not risen, have reached for better yields by purchasing more speculative bonds.

The dollar is weak, and the big story of 2005 may be efforts by Europe and the United States to force China and other Asian nations to allow their currencies to rise. In that atmosphere, one might expect foreigners to shy away from dollar-denominated corporate bonds, fearing that currency losses could more than offset interest income.

But so far that has not been the case. The Treasury Department reported this week that foreigners bought $45 billion in American corporate bonds in September, by far the largest monthly total ever. In the last 12 months, almost $300 billion in foreign money has gone into such securities, 22 percent more than the year before. The money financing the trade deficit must go somewhere, and foreigners are dubious about American stocks. A lot goes into Treasuries, but their yields are even lower than corporate bonds'.

Is the lack of worry reasonable, or a sign of dangerous complacency? The margin for error is obviously greater when there is little in the way of extra compensation for taking on risk. At the moment, the yield premium on speculative bonds -- whether denominated in dollars, pounds sterling or euros -- is a third or less of what it was just two years ago, according to Lehman Brothers data.

''We are reaching levels that are clearly unsustainable,'' said Guillaume Menuet, an economist at Moody's in London, speaking of the small yield premiums. ''The question is how fast they will go up.''

It may be that within a year or two it will appear that the biggest risk that investors took was the decision to act as if there were no risks.

Graph tracks the difference between banks reporting higher profit margins on business loans and those reporting declining margins since 2000.